EU Financial Watch Dog Warns Investment Properties Could Be Overpriced

With yield-hunting investors pouring their cash into investment properties across Europe, the EU’s financial watchdog has urged caution. The European Systemic Risk Board (ESRB), part of the European Central Bank, publishes an annual report highlighting risks it perceives to financial stability in the Eurozone. This year a key focus of that report was the increasing exposure of investors to Europe’s residential and commercial property markets, at price levels it fears show signs of being over-inflated.

With regard to commercial property, the report warns:

“High investor demand and the search for higher yields, which have been a major source of the commercial real estate price increase, particularly in prime markets, have potentially made investors vulnerable to a repricing of risk premia.”

And the ESRB are concerned this heightened risk profile is not restricted to just the commercial property market. It also sees strong potential for a significant correction in residential housing valuations:

“In many EU countries, the positive house price dynamics have been coupled with signs of overvaluation, which could generate losses for banks and other financial intermediaries involved in real estate financing should the real estate market experience a significant downturn.”

The record low interest rates of the past decade are pinpointed as the major factor behind residential property price inflation. As a department of the ECB, it can be presumed that the highlighting of the role of interest rates could hint at the prospect of impending hikes. Or at least a warning that when interest rates are increased, investors and property investment financers could find themselves over-exposed, especially if a significant valuations correction accompanies raises. If valuations do prove to be over-inflated that could be expected.

The good news is that unlike during the lead up to the 2008 international financial crisis, financial institutions do not appear to be overly exposed to property market debt backed by properties the value of which could slump. At least in the commercial property investment sector where “bank credit for commercial real estate has been muted”.

The current flow of cash into European property has instead been stimulated by low interest rates and a decade of quantitative easing with easy money flowing into property as an income generating asset. With Mario Draghi also instructing Eurozone politicians to prepare a new round of stimulation to boost its decelerating economy, the ESRB warning could be a timely warning to prevent it being funnelled into more prime commercial property assets.